January is Financial Wellness Month. This is a great way to think about ways we can manage our financial lives “well.” I help my wealth management clients do this by analyzing their current financial situations and seeking ways to improve them. An improvement in your current financial life is an improvement in financial wellness. The term “Financial Wellness” is also a program through which I work with an employer to create and implement financial workshops, one-on-one consultations for employees, and other related services. When I am working with clients and employees, I start the process by helping them understand how to better manage their personal financial lives by focusing on 5 key areas: budgeting and saving; debt management; investing for the future; insurance and risk management; financial goal setting and planning.
1. Financial goal setting and planning
The first step is to take inventory of what you really want in life. It’s difficult to effectively manage anything without understanding what positive progress looks like. With investing, we typically measure our success by comparing returns to benchmarks. Goals can act as our personal financial benchmarks.
To set goals, we can think about what we really want to do or achieve in life that would leave us with a comfortable feeling of accomplishment? Visualization is a great process to use here. Think about the time you accomplished something that you were proud of. Use the 5 W’s to paint a vivid picture:
- What was this accomplishment?
- Who was involved?
- Where were you when this happened?
- When did this occur in your life?
- Why are you proud of this accomplishment?
Once you have visualized the situation, think about how you felt. Did you feel a tingle in your stomach? Were you energized? Did you feel warmth throughout your body or was it just in one area? This “feeling” aspect of goal setting can help us determine what goals are worth working toward.
2. Budgeting and saving
Now that you know what you want to accomplish in life, you need to put a price tag on everything. If one of your goals is to help your kids go to college, how much money do you need to have saved for them and when does it need to be available? If you are going to save and budget, you need a reason. Otherwise, why would you do it?
One major goal you should strongly consider adding here is building an emergency fund. This is usually savings equal to 3-6 months of expenses (or income, depending on your preference). Your preference is dependent on how you position it in your cash flow planning, which is beyond the scope of this blog. This is such an important goal that I typically position it as a top priority in wealth management.
When you have put a price tag on everything, start adding up the costs. Look at a timeline and determine when you need to have money to accomplish each of your goals. This helps you know how much money you need to save between now and then and how much risk you are willing to assume for each investment.
The next step is our reality check.
- Calculate your monthly income and how much is left each month after spending on bills and life.
- If there is anything left over, think about how much you are willing to dedicate to your goals.
- Annualize this by multiplying by 12.
- Compare your goals and timelines with your income and savings to determine whether you are realistic or not.
If there is not enough money to pay for all your goals, you will need to prioritize them and confirm the ones you choose to move to a list of dreams. The list of dreams is where things go when we would love to have them if something changes financially. Life can often deliver unexpected positive financial surprises like promotions, pay raises, and inheritance. When these things happen, it’s best to have a list like this to help make logical decisions.
3. Debt management
Debt is not always bad, but it can and often does get out of control and endangers our ability to achieve our goals in life. What is the difference between bad and good debt?
While there is debate around the exact definitions of “good” and “bad” debt, we generally refer to bad debt as any debt that you cannot afford or that doesn’t move you toward your goals. If you can’t make the payments or if the interest rate is too high, you can’t afford it. Examples of bad debt are check-cashing services, revolving credit card balances, and excessive auto loans. Even the “12 months same as cash” deals can be bad debt. These deals can impact your credit score and cause your borrowing rates to go up.
Good debt, on the other hand, moves us closer to our goals. Borrowing within our budget for a car, house, or college degree can have a positive impact on our financial lives. Just be sure to keep track of how much you are spending in interest.
If you are ever going to sign a contract to borrow money or purchase something through a loan, you can add up all the interest you will pay over the period of the loan. If running that calculation isn’t something you are comfortable with, ask the salesperson to run it for you. Either way, it can really put things into perspective. Also, make sure you keep a summarized list of all loans you have active. This helps with debt management and it is very helpful for estate planning, in the event of an untimely death.
4. Insurance and risk management
Unfortunately, life has a habit of not following our planned events and goals. Often, this can be positive, as mentioned previously in the key area of Budgeting and Saving. However, negative things can happen unexpectedly, as well. These untimely events are risks that we assume every day. It’s important to understand our risks and how they might impact our lives. The good news is that we have options on how we want to manage risks. There are primarily 4 ways to manage risk: Risk Retention; Risk Reduction; Risk Avoidance; and Risk Transfer.
- Risk Retention: We can choose to take our chances. Using this method, we need to calculate the potential this risk can occur and how much it can cost if the risk does occur. It helps to see how it might impact your detailed financial plan. If you have a swimming pool in your backyard, this is the equivalent of not putting a fence around your pool or backyard. You are assuming any risks associated with swimming pool accidents.
- Risk Reduction: Using this method, we may be able to reduce the odds of the risk occurring. An example of this would be putting a fence around the backyard or pool. The neighborhood kids might sneak into the yard for a dip, but it is less likely when you have a fence.
- Risk Avoidance: Sometimes, you may be able to avoid a risk altogether. You might decide not to put a swimming pool in your backyard. Then, there would be no worry about lawsuits related to swimming pool accidents.
- Risk Transfer: This method of risk management usually involves insurance of some type. The financial risk associated with a lawsuit from a swimming pool accident can be transferred in part or in whole to an insurance company. Other forms of risk insurance are disability insurance (covers varying degrees of inability to work), life insurance, and long-term care insurance (often covers at-home care, assisted living, and nursing homes).
I have a client who has been very successful in life who once told me that they were “insurance poor.” What they meant was that they had insurance for just about every risk imaginable and a major portion of their income was going toward risk management. While this client did have an insurance policy with me, they had many other policies that they had acquired over the years from different agents. The point is that most of us have a limited amount of income we can spend on insurance. We need to make it count, and this is where a good wealth manager can be helpful. Analyzing your current risk management plan and determining whether you have enough or too much coverage can help you prevent a financial disaster or make more money available for other goals by eliminating unnecessary insurance policies.
5. Investing for the future
This last key area is where we carefully plan how we want to invest that portion of our income that is set aside for our goals. There are many volumes of articles, books, programs, etc. on the topic of investing, and I can’t even scratch the surface in this blog. However, as it relates to personal financial well-being, one key to good financial planning is to invest based on your goals. I like to do this by first defining goals as short-term (less than a year), medium-term (1-5 years), and long-term goals (more than 5 years).
The next step is to determine how much risk we are willing to take with the money we are setting aside for these goals. That will help determine the type of investments we should consider for each of our goals and investment portfolios. Lower risk investments usually produce lower returns while higher risk investments often produce higher returns (see Five Important Aspects of Investment Risk).
If the returns we can expect to get for the investments we set aside for our goals are not enough for us to achieve our goals, we must decide whether we want to increase our risk, reduce the cost of our goals, reduce expenses, or make more money. Another option is to eliminate a specific goal and shift the money for that goal over to another one.
By focusing on these 5 key areas, you may be able to achieve some or all the goals you have in life. I have seen many successful retirements or partial retirements over the years, and these were often the highest goals for those clients. Seldom have I seen successful retirements happen without careful planning and hard work. It’s not an easy slog, but there are ways to make it enjoyable along the way. Financial planning can help us do that by giving us a better idea of how to manage our personal financial lives, which can lead to confidence and happiness (https://counsellingresource.com/features/2015/10/27/money-and-happiness/). While this summary makes a complex subject sound simple, it is far from easy. Discussing it with a qualified wealth manager like me may help you uncover goals or ways to balance enjoying your life with budgeting, saving, and investing. The earlier you get started, the more time you have to plan, save, and invest for your goals. That is a great way to start the year!